Economist: Trade Disruption, Not Rate Hikes, Is Real Concern for Commercial Real Estate

WASHINGTON, D.C. — The Federal Reserve opted Wednesday to raise the federal funds rate by a quarter of a percentage point. The overnight rate that banks charge one another for loans now stands at an even 2 percent, with two more rate hikes expected to occur before year’s end.

According to one economist, however, the nation’s central bank could abandon its pursuit of a tighter monetary policy if the capital markets experience a major disruption.

Rajeev Dhawan, director of the economic forecasting center at Georgia State University in Atlanta, believes there is no more plausible and imminent economic disruptor than President Donald Trump’s trade policies.

Rajeev Dhawan, Georgia State University

“The commercial real estate industry shouldn’t be worried about rate hikes, which are happening in baby steps,” says Dhawan. “If the cash flows on your properties are there, who cares about the rate hikes? The real thing to worry about is what happens in the interest rate market as a result of trade developments.”

Rate Hikes Foreseen

Most borrowers in commercial real estate anticipated an increase in short-term interest rates. After all, these figures had nowhere to go but up after hovering around zero for several years in the post-recession era.

Borrowers generally responded by locking in fixed interest rates for longer terms in advance of the rate hikes, in many cases taking advantage of lower-leverage structures like CMBS and life company loans.

As such, the interest rate hikes are not really causing major headwinds in the commercial real estate industry. With the economy operating at a 3.8 percent unemployment rate and both consumers and businesses enjoying more disposable income from the Tax Cuts and Jobs Act, the June rate hike was a basic and necessary action to prevent the economy from overheating.

In fact, the real danger to commercial real estate borrowers stems from the possibility that the Fed will not pursue additional rate hikes before year’s end.

The Trump administration recently imposed a 25 percent tariff on imported steel and a 10 percent tariff on imported aluminum on several of America’s longtime trading partners. These countries include Canada, Mexico and member nations of the European Union (EU). The administration has threatened China with similar trade sanctions and is reportedly close to announcing formal tariffs on the world’s most populous country.

Trade practices could impact the capital markets side of the commercial real estate business, primarily by discouraging investment in U.S. real estate from foreign sources of capital.

“One of the reasons interest rates were so low for so long is because so many foreign sources of capital have come to the U.S. to invest their money,” says Dhawan. “If we enforce restrictions, there will be less dollars being circulated, which could compound the impact of rate hikes and other deflationary measures.”

A Necessary Evil

Dhawan also notes that overall valuations of commercial real estate assets have appreciated tremendously in the current cycle. Between a basic increase in pricing and strong rates of rent growth, small, foreseen interest rate hikes represent a manageable task for borrowers.

In fact, incremental rate hikes are a key stabilizing mechanism in today’s market. According to Dhawan, rate hikes are essential to the commercial real estate industry because that sector tends to evaluate the economy based on unemployment. As the main driver of commercial real estate activity, job growth sometimes becomes a one-dimensional lens through which the economy is viewed. But that’s an erroneous approach, he says.

“Looking at the economy through the unemployment rate is like trying to evaluate someone’s heart health with nothing more than a pulse,” says Dhawan. “It’s one indicator, but there are others, like GDP and inflation, that are more important to consider in today’s market.”

GDP, which Dhawan says represents income creation in the economy, grew by 2.2 percent in the first quarter of 2018 and 2.9 percent in the fourth quarter of 2017, according to the Bureau of Economic Analysis.

The difference in GDP growth between these quarters is significant, and it suggests that the economy is not growing at a steady rate. Until there is confirmation that the economy is growing by more than 3 percent on a consistent basis, there is no reason to abandon the small-scale rate hikes, says Dhawan.

— Taylor Williams

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